State of play

The world has reached a 1.1°C temperature increase since the Industrial Revolution and is on track to exceed 1.5°C by 2030 (the max temperature increase per the Paris Agreement). To stay on the 1.5°C trajectory, the UN Environment Programme (UNEP) says that annual global emissions will need to be reduced to 25 gigatonnes by 2030 (36.4 gigatonnes in 2021).

What higher temperatures mean for the planet:

• Water stresses to increase; today, four billion people experience severe water scarcity for at least one month per year and that is set to rise, according to UNICEF.
• This would drive increased climate migration, with large numbers set to be forced from their homes as drought and food shortages increase.
• As low-income countries are disproportionately affected by climate change, inequalities are likely to expand.

A break in consumer trust can be worse than having no environmental policy at all.

– Forbes

People’s environmental concerns have steadily grown since the 1990s, and the public is becoming savvier in seeing through greenwashing. Investors are feeling pressure from important stakeholders, with many banks reporting ESG as the most important point for their clients.

This is not only from an altruistic point of view – according to MIT Sloan, ‘clean tech’ has outperformed ‘dirty tech’ and as the systemic risks from climate change become more apparent in the news every year (forest fires, droughts, etc.), the sheer size of the economic opportunity becomes even more obvious. Money Marketing states that ESG funds currently account for 10% of worldwide fund assets, and the pressure to converge to more sustainable finance is intensifying with ESG assets under management (AUM) expected to reach £40tn by 2025.

Demographics is a major growth driver: ESG is at the forefront of young investors’ minds and female investors of all ages list ESG as one of the most important considerations that they make when assessing investments. Moreover, the Centre for Economics and Business Research expects 60% of UK wealth to be in the hands of women by 2025. Despite this demand, the two demographics have reported a lack of understanding of investment products, especially those in ESG, and better education and reporting are a necessity for them to deploy capital more effectively and in line with their values.

Sustainable investing

Counterintuitively, as the number of investment offerings branded as ‘sustainable’ or ‘impact’ grow, so too does the general dissatisfaction with the metrics. The phrase ESG has been semantically criticised, allowing companies to dilute their efforts versus the former name ‘sustainability.’

As an example, Blackrock has been one of the most vocal proponents of ESG investing, yet it rarely voted for ESG-related shareholder proposals until 2021 (81 out of 172). It recently stated that these proposals were becoming too prescriptive and constraining and that it will not be able to vote for many more. Another example is Volkswagen. The company strongly promotes its ESG credentials; however, according to The Financial Times, VW chief executive Herbert Diess is keen to re-enter Russia “regardless of the state of Ukraine’s Nationhood.”

Markets are looking for a more honest, realistic response to climate change. Investments in fossil fuels are still required to ensure a smooth transition to the new future, as shown by Carlyle actively looking for opportunities in oil and gas. However, according to the Financial Times, the company says it will use this opportunity to put pressure on its portfolio companies and promote collaboration between them to ensure that they are using more sustainable and lower-impact operations.

Nordea AM goes further – it has dismissed the notion that true ESG investing is about cherry-picking sustainable companies and believes that real impact comes when investors force companies to become greener. Money Marketing states that for investors to enact meaningful change, they must actively pursue companies that are essential to our current and greener future way of life (e.g., copper mining – required throughout the full electrified system, from solar cells to batteries).

The need to improve these resource-intensive companies is even more pressing as half the world’s GDP is reliant on nature and its services, as said by the World Economic Forum.

“Nature-positive transitions could generate £8tn of annual business value worldwide”

– World Economic Forum

The issue is accountability, and a lot of these developments and requirements cannot be captured in the current investment process. Although the opportunity is significant, it requires patient capital, away from worries about liquidity and quarterly performance. For that movement, investors need to quantify in a scientifically sound, transparent, and reliable way their exposure to risk, return, and impact.

What is being done

COP26 saw a concerted push for standardised reporting. Many ESG frameworks have emerged for companies to declare and highlight their metrics within this space. The first was from the World Economic Forum which partnered with the Big 4 to draw up standardised measurements of 22 metrics that companies can then report their results for the new ‘Stakeholder Capitalism’. However, the lack of implementation of globally standardised metrics has seen increased demand from investors for data, which has led to index agencies creating their own rating systems.

Regulations are starting to come into play across the world with varying levels of success and implementation. The SEC will require all companies with revenues greater than $75m to report emissions from their 2023 results. Europe has committed to being the first climate-neutral continent by 2050, which includes a large scope of measures and is expanded to areas such as biodiversity requirements. It requires companies with over 500 employees and a turnover of more than €40m to report their sustainability metrics in a standardised way – and has led to fund classifications (articles 6-8 SFDR).

More niche funds are being created where the purpose and therefore accountability to investors is more obvious, and many firms have launched biodiversity-focused funds. The Paulson Institute expects this to grow by more than 20x in AUM by 2030.

The problems

ESG has diluted the commitment to reducing emissions, the criteria have not been proven to reduce emissions, and there is limited correlation between the ESG score and the isolated E-score. Therefore, investing in high ESG scoring companies does not necessarily mean that you will contribute to reducing climate change. The lack of universal metrics also makes it difficult to compare; the recent adoption of regulation and individual, standardised reporting has yet to be tested and it is unknown if they will add value when they differ per jurisdiction.

Profit > impact: some companies are starting to tie executive bonuses to sustainability success, but these are not science-backed metrics and add to the allusion of greenwashing. Sustainability is always separated from core company activities and as long as sustainability is ‘nice to have,’ separated from profit, the needed results will not happen.

Counting the true cost of a nation’s emissions is difficult, and offshoring emission to other (more lenient) countries does not make the world any better, only serving to muddy the waters and game the system. Furthermore, it shifts the blame, similar to companies stating that they will move to greener methods / products when the consumer wants it.

To have any chance of meeting the emission reduction targets and to empower investors / consumers to drive actual change, it is imperative to separate the E from the almost completely unrelated S and G. By taking each letter on its own, a company’s real impact can be transparently assessed, and goals more easily set, allowing for them to be held to account by all stakeholders, reducing greenwashing and driving real, sustainable initiatives.

About GP Bullhound
GP Bullhound is a leading technology advisory and investment firm, providing transaction advice and capital to the world’s best entrepreneurs and founders. Founded in 1999 in London and Menlo Park, the firm today has 12 offices spanning Europe, the US and Asia. For more information, please visit www.gpbullhound.com.

Sources
Forbes
Actuarial Post
Money Marketing
Worth
Financial Times
Bloomberg
Paulson Institute
MIT Sloan Management Review
UNICEF
ReliefWeb
Oxfam
Robeco
BNP Paribas
European Commission
Ascentys
The White House
Forbes
Fitch Ratings
Reuters
World Economic Forum

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